Cost Segregation for S Corps: How 100% Bonus Depreciation Changes the Strategy

For years, cost segregation was primarily associated with larger commercial real estate investments. For an S corporation that owned its own office, warehouse, or other commercial property, the cost of a study could be harder to justify. The One Big Beautiful Bill Act (OBBBA) changed that calculation.

With 100% additional first-year depreciation permanently restored for qualifying property acquired and placed in service after January 19, 2025, cost segregation can make it possible to accelerate deductions on eligible components of commercial property. For an S-Corp, that can mean a potentially significant first-year deduction rather than waiting years to recover those costs through depreciation.

What Does a Cost Segregation Study Do?

Commercial buildings generally use a 39-year federal depreciation period, while residential rental buildings use 27.5 years. However, a building contains components that may qualify for shorter recovery periods, including 5-, 7-, or 15-year property. A cost segregation study uses engineering and tax analysis to identify and reclassify qualifying assets.

Examples can include specialty lighting, certain electrical systems, plumbing fixtures, equipment-related components, flooring, security systems, parking areas, and landscaping. The building’s structural components generally remain 39-year property. Qualified improvement property — most interior improvements made to a nonresidential building after the building itself is placed in service — is its own category with a 15-year recovery period under §168(e)(6), which also makes it eligible for bonus depreciation.

When eligible reclassified components qualify for 100% bonus depreciation, an S corporation may be able to deduct their entire tax basis in the year the property is placed in service.

The amount identified through a study varies substantially by property type and construction. There is no guaranteed percentage or universal property-value threshold for determining whether a study is worthwhile.

How Cost Segregation Works for an S Corporation

Subchapter S companies generally claim the depreciation deduction, which then passes through to shareholders on their Schedule K-1s. However, a large deduction does not automatically mean every shareholder can use it immediately.

Shareholders must consider stock and debt basis, at-risk rules, passive activity limitations, and other applicable loss limitations. The passive activity rules deserve particular attention when the building is rented out: rental activities are generally treated as passive per se under §469, so unless a shareholder qualifies as a real estate professional or the self-rental rules recharacterize the income, a large first-year depreciation loss may be suspended and carried forward rather than deducted immediately against wages or other nonpassive income. The actual tax benefit therefore depends on each shareholder’s circumstances.

What About Property You Already Own?

An S-Corp that previously placed qualifying property in service without performing a cost segregation study may, in many circumstances, use an accounting method change to claim allowable depreciation that was missed in earlier years. This typically involves Form 3115 and a §481(a) adjustment rather than amending every prior return. The switch from an impermissible to a permissible depreciation method appears on the IRS’s current list of automatic accounting method changes in Rev. Proc. 2025-23, so advance IRS consent is generally not required, and the missed depreciation is claimed as a catch-up adjustment in the year of change. Eligibility and filing requirements depend on the taxpayer’s specific facts and the applicable IRS procedures.

State Taxes and Depreciation Recapture

Federal and state treatment can differ significantly. States including California, New York, and New Jersey have rules that may require adjustments to federal bonus depreciation. S corporations should model the state consequences separately rather than assuming the federal deduction applies automatically.

Cost segregation also affects the property’s tax basis. When the property is sold, some components may be subject to §1245 ordinary-income recapture, while other real-property components may fall under §1250 rules. The accelerated deduction is therefore primarily a timing benefit, not permanent tax elimination.

One structural point worth raising before any of this: appreciated real estate held inside an S corporation is hard to get back out. Distributing the building to a shareholder is treated as a sale at fair market value under §311(b), triggering gain that passes through to the shareholders, which is why many owners hold real estate in a separate LLC rather than inside the operating S-Corp. For S corporations considering a cost segregation study, the best approach is to model the federal and state tax impact, shareholder-level deduction limitations, study costs, holding period, and potential recapture before proceeding.